3705 / What is a SAR-SEP? What requirements must be met if a simplified employee pension is offered on a cash or a deferred basis?

A SAR-SEP is a simplified employee pension that is offered on a salary reduction (i.e., a cash or deferred) basis. In other words, the plan permits individual employees to elect to have contributions made to the SEP or to receive the contribution in cash. A SEP must otherwise meet the requirements in Q 3701, as well as those explained below, and the plan had to be established before 1997. No new SAR-SEPs are permitted after 1996, but those in effect prior to 1997 may continue to operate, receive contributions, and add new employees.¹

A SAR-SEP may be maintained by an employer who had 25 or fewer employees who were eligible to participate in the plan at any time during the prior taxable year. The amount that an employee chooses to defer and contribute to the SEP is referred to as an elective deferral. Elective deferrals ( Q 3760) are subject to the same cap ($23,500 in 2025 (projected), $23,000 in 2024, $22,500 in 2023, $20,500 in 2022, $19,500 in 2020-2021, and $19,000 in 2019) as elective deferrals to IRC Section 401(k) plans.² Elective deferrals also are subject to FICA and FUTA withholding.³ Certain lower income taxpayers may be eligible to claim the saver’s credit for elective deferrals to a SAR-SEP ( Q 3648).

In addition to the elective deferrals described above, a SAR-SEP may permit additional elective deferrals by individuals age 50 or over, referred to as “catch-up contributions.”⁴ The dollar limit on catch-up contributions to a SAR-SEP is $7,500 in 2025 (projected), $7,500 in 2024, $7,500 in 2023, $6,500 in 2020-2022 and $6,000 in 2017-2019.⁵ For details on the requirements for catch-up contributions, see Q 3761.

Contributions made by an employer on behalf of an employee to a SAR-SEP are excludable from the employee’s income to the extent that they do not exceed the lesser of 25 percent of “compensation” from the employer, or $70,000 in 2025 (projected).⁶ As a result of an apparent oversight by Congress, “compensation,” for this purpose only, is includable compensation (i.e., does not include elective deferrals).⁷